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Margaret Moran
Margaret Moran
Articles (348) 

Investing in Turbulent Real Estate Stocks

Shifting property values could make REITs a value buy, especially in the industrial sector

April 15, 2020 | About:

With Covid-19 shutdowns shaking the economies of countries around the world, the demand for different types of properties is shifting as well. As consumers up their spending on food, other essentials and delivery services, the owners of warehouses and similar industrial properties expect the long-term value of their properties to increase, even as other types of real estate are expected to see a decline in value.

“There are a wider range of consumers shopping online, and a wider range of products for which they’re shopping,” Chris Caton, head of global strategy and analytics for industrial property landlord Prologis Inc., said. “We found a majority of our customers are going to be stable or even grow.”

Overall, Prologis expects that the demand for warehouse property will weaken in the short term as the economy enters a period of recession. While the need for warehouses is increasing, as indicated by Amazon ramping up hiring for its warehouses and the fact that retail merchandise will still need a place to go even if consumers aren’t buying, many companies will lose the ability to pay for storage as debt and lack of income weigh on their balance sheets.

Meanwhile, Flexe Inc., which helps connect businesses with extra storage space in their warehouses, has reported a spike in demand from online retailers and cleaning supplies providers as these business rush to keep up with rising sales.

Changes in consumer buying patterns are likely to have more than a short-term effect on how companies go about storing their inventory. The practice of only storing what is expected to be sold in the immediate future in order to cut down on warehouse costs has become a burden for online retailers and suppliers of essential products such as food and cleaning supplies, meaning that the demand of these businesses for storage space could increase as the economy recovers.

On the other hand, with U.S. gross domestic product expected to drop as much as 40% for the first half of 2020 according to estimates from JPMorgan Chase & Co. (JPM), the largest bank in the U.S., retailers of non-essential products that were already keeping the lights on with mostly borrowed money could find themselves unable to pay rent as their profits evaporate. Similarly, with unemployment expected to hit 10% to 20%, individuals living paycheck to paycheck will be unable to pay their rent and mortgages. This will likely lead to increased foreclosures and subsequent decreases in value for retail and residential properties.

With experts anticipating the value of industrial, residential and retail properties to decrease in the short term, with faster growth in the long term for industrial properties, it may be helpful to take a look at how real estate investment trusts for these types of properties performed during past recessions. Of course, past performance is not a predictor of the future, and in this case, it could even be misleading in some ways.

Industrial

First Industrial Realty Trust Inc. (NYSE:FR) is a leading owner of industrial real estate. It owns, operates and develops millions of square feet of logistics properties and maintains a presence in top U.S. industrial areas, leasing to over 1,000 clients. On April 15, shares of First Industrial traded around $35.25 for a market cap of $4.48 billion and a price-earnings ratio of 18.44.

The chart below shows First Industrial’s stock price, revenue and net income history. During the dotcom bubble, the company went through little change, as this was mainly a stock bubble. However, during the 2008 financial crisis, the company saw a brief spike in revenue, accompanied by a steep drop in net income and share price before profits began to pick up again in 2011.

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The Great Recession caused a manufacturing crisis, with the industrial sector being the hardest hit. For example, according to the U.S. Federal Reserve’s industrial production index, steel production dropped 37.2% between August and December of 2009 as the bottom fell out of the auto industry.

Given the drop in demand for non-essential products, the full extent of which will remain unknown until after the fact, it seems likely that the U.S. economy will see a similar short-term collapse in manufacturing, even as online and essential products retailers increase their demand for warehouse space.

Retail

Moving on to retail, perhaps the most famous retail REIT is Realty Income Corp. (NYSE:O), which is known for its staunch dedication to maintaining its monthly dividend. It purchases and leases free-standing, single-tenant commercial properties in the U.S., Puerto Rico and the U.K. that are subject to triple-net leases, in which tenants must pay all the expenses of the property. On April 15, shares of Realty Income traded around $51.50 for a market cap of $17.73 billion and a price-earnings ratio of 37.04.

Looking at the below chart, we can see that this REIT saw only slight effects from the financial crisis. While the share price fell approximately 45%, both revenue and net income remained little-changed.

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In this respect, it is hard to tell whether history will repeat itself for this REIT. The companies most vulnerable to being unable to pay rent are the small businesses and the medium-sized businesses that have seen their profits evaporate during the lockdown. Thus, Realty Income, whose clients include the likes of The Home Depot (HD) and Walmart’s (WMT) Sam’s Club, may be less effected.

A company like Kimco Realty Corp. (NYSE:KIM), which owns shopping centers, will likely be more affected; after 2008, Kimco saw its stock price and net income plunge, followed by sluggish top-line growth and little net bottom-line growth.

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Residential

Representing residential REITs, we will take a look at Investors Real Estate Trust (NYSE:IRET), which owns apartment communities across the U.S. Midwest region (Colorado, Nebraska, etc.). In total, it owns and manages 70 apartment communities consisting of approximately 12,000 units. On April 15, shares of Investors Real Estate Trust traded around $57.17 for a market cap of $695.94 million and a price-earnings ratio of 9.53.

According to the chart below, we see that the REIT’s top line actually increased in 2008 and 2009 as the net income and share price showed moderate declines.

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This partially reflects an increase a shift toward apartment rental over home ownership in light of the subprime mortgage crisis at the time. According to data from RealtyMogul.com, U.S. home ownership has reached its lowest level since the 1960s as Americans are increasingly choosing to rent instead of own. The change is due to a variety of factors, ranging from an increased mortgage threshold after the financial crisis to generational preferences.

As renters across the U.S. lose their jobs, those living paycheck to paycheck will not be able to pay their rent. This is not necessarily a dire sign for apartment owners; with the worst estimates for unemployment at 10% to 20% and some having money in savings, the only landowners in real danger of being foreclosed on are the ones who don’t keep a rain-day fund. With an Altman Z-Score of 0.67, Investors Real Estate Trust might need to take on more debt in order to avoid becoming one of these cases.

Conclusion

REITs are profitable investments overall due to their high dividend yields and the stability of their assets. They range in volatility from the more stable residential REITs to the more variable industrial REITs, depending on how likely their properties are to fall out of use during times of economic decline.

However, Covid-19 lockdowns and high corporate (and individual) debt could create a lack of ability to meet financial obligations that has not been seen in most people’s memories. The shake-up has experts in the industrial field anticipating long-term changes in the way businesses move and store goods, which would increase the demand for warehouse and industrial spaces for many years to come.

Disclosure: Author owns no shares in any of the stocks mentioned. The mention of stocks in this article does not at any point constitute an investment recommendation. Investors should always conduct their own careful research or consult registered investment advisors before taking action in the stock market.

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